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  <h1>Insolvency and closure</h1>

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  <p class="toc_title">Contents</p>
  <ul class="toc_list">
    <li><a href="#question_1_1">Insurance companies</a>
    </li>
    <li><a href="#question_1_2">Employer-sponsored pension schemes</a>
    </li>
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    <span id="question_1_1">Insurance companies</span>
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      <p>
      An insurance company is insolvent if it is unable to meet its liabilities as they fall due, or does not have assets in excess of the <span class="highlight">(statutory)
      value of the liabilities (plus any Statutory Minimum Solvency Margin).</span>
      <br>
      Regular statutory reporting allows the regulator to monitor the financial position of individual companies and, if necessary, to intervene in the running of a company before insolvency occurs.
      <br>
      If the SMSM is breached, the company will be required to produce <span class="highlight">a recovery plan</span>, which will
      then be <span class="highlight">monitored by the regulator</span>.
      <br>
      A recovery plan: cutting down unnecessary expenditure. Make some structural changes to the company to improve solvency position.
      <ul>
        <li>
          The regulator will have regular reporting requirements to track the capital position of company.
        </li>
        <li>
          The regulator may increase the frequency of monitoring of the capital position
        </li>
        <li>
          The regulator may become more closely involved in the management of the company
          <ul>
            <li>
              adopting a more matched investment strategy.
            </li>
            <li>
              requiring additional reinsurance cover to be purchased.
            </li>
            <li>
              limiting the amount of new business sold
            </li>
            <li>
              restrict the asset classes the company can invest in, insist on a certain ALM  approach. The company itself could take this action voluntarily to improve capital coverage
            </li>
            <li>
              managing the expense position or claims philosophy. Again, the company itself could take this action voluntarily to improve capital coverage
            </li>
            <li>
              The severity of any actions taken by the regulator will depend on the degree to which the company is below required capital threshold
            </li>
          </ul>
        </li>
      </ul>
      However, in extreme cases, the regulator may close the company to new business to protect the interests of existing and prospective policyholders.
      <ul>
        <li>
          Preventing the company from writing new business should result in a significant cost saving in the short term (e.g. costs associated with sales and marketing).
        </li>
        <li>
          In addition, there will be a release of capital previously tied up to finance new business.
        </li>
        <li>
          Thus, even in extreme cases, the company should be able to meet any immediate outstanding liabilities.
        </li>
      </ul>
      However, in the longer term,
      <ul>
        <li>
          dis-economies of scale (i.e. spreading the fixed costs over fewer in-force policies) can lead to further problems.
        </li>
        <li>
          Thus, it may be that the regulator will require that the insurer is sold or merged with another provider who takes on responsibility for the liabilities.
        </li>
      </ul>
      However, in practice, this may prove difficult. if company is making losses (or has a book of poor-quality business), it may be difficult to find a buyer.
      <br>
      Where the company cannot meet the outstanding liabilities and a buyer cannot be found, there may be a statutory fund (statutory bailout fund) from which some of the outstanding liabilities can be met.
      <br>
      Such a scheme is usually funded by a regular levy on all authorised providers in the market.
      <br>
      What are the main advantages of such a scheme?
      <ul>
        <li>
          it provides security for policyholders in the event of an insurance company becoming
          insolvent, ensuring that the policyholders receive most (if not all) of the promised benefits
        </li>
        <li>
          this, in turn, is likely to increase consumer confidence in the insurance market, which might lead to higher business volumes (and, hence, profits)
        </li>
      </ul>
      What are the main disadvantages of such a scheme?
      <ul>
        <li>
          Moral hazard – i.e. may encourage insurers to take on more risks (as they can benefit if things go well and statutory fund will bail them out if things go wrong).
        </li>
        <li>
          System failure can hardly be recovered using it. If a number of companies fail at the same time, which is totally possible due to some global financial crisis, then fund may be unable to cover all losses.
        </li>
        <li>
          the annual levy is likely to lead to higher insurance premiums (or lower profits for insurance companies)
        </li>
      </ul>
      </p>
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    <span id="question_1_2">Employer-sponsored pension schemes</span>
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      <p>
        An occupational pension scheme may be closed as a result of
        <ul>
          <li>
            insolvency of the sponsoring employer
          </li>
          <li>
            or, simply, because the sponsoring employer elects to stop financing the benefit provision.
          </li>
        </ul>
        In this case, consideration needs to be given to the benefits payable to the members of the scheme at the closure date.
        <br>
        It is important to distinguish between:
        <ul>
          <li>
            the rights of the beneficiaries under the terms and conditions of the scheme (and any over-riding legislation), and
          </li>
          <li>
            the expectations of the beneficiaries, which are likely to be based on the benefits that would have been paid on retirement had the scheme not been discontinued
          </li>
        </ul>
        In practice, legislation is likely to be in place to define the benefit rights of the different classes of members, in particular:
        <ul>
          <li>
            active members will usually be entitled only to the benefits that would have been received if the member had left the scheme voluntarily on the discontinuance date
            <ul>
              <li>
                i.e. a deferred pension payable from NRA based on current salary and past pensionable service only. The link to the final salary is broken.
              </li>
              <li>
                this will usually be revalued in the period prior to retirement (to reduce erosion as a result of inflation)
              </li>
            </ul>
          </li>
          <li>
            current pensioners, however, would usually be entitled to a full continuation of any pensions in payment (including any guaranteed pension increases and spouses’ pensions)
          </li>
        </ul>
        Defining the benefit expectations of members is more difficult and will usually be a matter of judgement.
        <br>
        What factors are likely to influence members’ benefit expectations?
        <ul>
          <li>
            benefits outlined in trust deed and rules of scheme,
          </li>
          <li>
            any discretionary benefits currently (or previously) paid to other members
          </li>
          <li>
            benefits provided in other schemes
          </li>
          <li>
            Priority of members – payments of existing pensioners may be honouredx
          </li>
          <li>
            Whether the scheme is solvent
          </li>
          <li>
            Whether there is a debt on the employer and whether the employer can meet it if so
          </li>
          <li>
            Potential for recourse to a nationwide protection fund
          </li>
        </ul>
        For example, active members may have an expectation for:
        <ul>
          <li>
            accrued benefits to date to be based on final salary (rather than current salary), and
          </li>
          <li>
            accrual of future service benefits in period prior to retirement
          </li>
        </ul>
        In some cases, they may even have an expectation for enhanced early and/or ill-health retirement benefits.
        <br>
        Current pensioners may have an expectation for any discretionary increases to pensions in payment to continue in future.
        <br>
        In practice, in the event of a scheme discontinuance, it is highly unlikely that the assets of the scheme will be sufficient to meet the expectations of the beneficiaries.
        <br>
        because, in practice, scheme is likely to be wound up only if it does not have sufficient assets to meet the current accrued liabilities.
        <br>
        What circumstances are likely to lead to a scheme discontinuance? employer has decided that cost of providing the promised benefits has become unsustainable. bankruptcy of employer. takeover/merger.
        <br>
        Indeed, it will often be the case that <span class="highlight">
        there are insufficient assets even to meet the minimum benefits promised as of right.</span>
        <br>
        In this case, the scheme trustees will have to ensure that the available funds are shared between the different groups of beneficiaries as fairly as possible.
        <br>
        In practice, scheme rules and over-riding legislation will also have to be considered here.
        <br>
        Suppose that, on discontinuance, the assets of the scheme are equal to 80% of the total minimum benefits promised as of right to the all of the scheme’s beneficiaries.
        <br>
        Why is it usually considered unfair to simply give each member benefits equal to 80% of those promised?
        <ul>
          <li>
            Because current pensioners have no opportunity to make good the shortfall in the benefits provided. Current active members could save more towards retirement
            and/or retire later to increase their pension in retirement.
          </li>
        </ul>
        In the event of discontinuance, legislation may require that any pension scheme debt is placed on the insolvent employer
        <br>
        This debt may rank above, alongside or even below other debtors (so, in practice, any recovery will be far from guaranteed).
        <br>
        In addition, any expenses associated with the discontinuance of the scheme (e.g. legal, administration and actuarial costs, costs of realising investments) will usually have first call on the assets.
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  <p> Author: Mengke, Lyu</p>

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